New President, same inadequate economic tools

By J Saft
November 5, 2008

James Saft — James Saft is a Reuters columnist. The opinions expressed are his own —

By James Saft

LONDON (Reuters) – President-elect Barack Obama will have to confront the same intractable economic problems with the same inadequate tools.

The banking system remains impaired and will require more taxpayer support. The impact of one percent official interest rates will still be blunted by the congestive failure of banking. There also isn’t much more in interest rate to cut before the United States looks rather, well, Japanese.

House prices are still falling and will continue to wear away at banking solvency.

Stimulative spending by the government will help, but it too can only do so much. Consumers are likely to use a fair part of any new government checks to pay down debt and save for coming difficulties, rather than rushing out to spend. Infrastructure projects, while sorely needed, will take quite a bit of time to get up and running.

The international economic situation has also deteriorated rapidly, taking away demand for U.S. products. What’s more, there is a very real risk some time in the next year foreigners become less willing to finance the massive borrowing the United States will need, imposing a limitation Obama’s predecessors were lucky enough not to face.

U.S. borrowing plans and debt obligations have mushroomed in the past six months, as the country moved to bail out its financial industry and provide some limited succor to consumers. Taking mortgage companies Fannie Mae and Freddie Mac into conservatorship has also at a stroke hugely increased the amount of debt for which the taxpayer is effectively on the hook, though without much improving the flow of mortgage money to a housing market that is still falling.

While marketable government debt securities were only about equal to 30 percent of gross domestic product at the end of 2007, if Fannie and Freddie debt is included that figure now hits closer to 75 percent. There is also a $700 billion bank bailout to finance, as well as Obama’s $175 billion stimulus package, which could easily end up being considerably bigger.

“Funding for the U.S.’s fiscal deficit remains inextricably linked to the appetite of foreign investors to hold increasing amounts of assets,” Naomi Fink, a strategist at Bank of Tokyo-Mitsubishi UFJ in Tokyo wrote in a note to clients. “There are increasing arguments for foreign investors to reallocate existing assets toward ‘value’ stocks rather than to absorb new U.S. debt issues, at current low yields.”

A reallocation away from U.S. debt into any other asset, or even an unwillingness to purchase more of it as more becomes available, would in some mixture drive U.S. interest rates higher and weaken the dollar.


There will inevitably be much talk about how a new administration will avoid the policy errors of the past and inspire confidence. There certainly are plenty of past errors to avoid; much of official policy seemed to be centered on winning “confidence” by denying the scope of the problem with one hand while furiously bailing out counterparties with the other.

But even with the best will in the world towards the new administration, the fact is that debt deflation, a global recession and at best comatose and at worst insolvent banking system won’t really respond to new brooms.

The run of data in recent days has been truly brutal. After a time, probably well before the inauguration, this will be what transfixes the market.

The Institute for Supply Management said its index of national factory activity fell to 38.9 in October from 43.5 in September. A reading below 40 is both exceptionally weak and the lowest in 26 years.

A report showing U.S. private employers cut 157,000 jobs in October strongly indicates a very harsh official reading on job numbers this Friday and continued pressure on employment and consumer spending.

The Fed’s October senior loan officers’ report showed market tightening of credit conditions since July, when conditions were hardly loose, especially for commercial and industrial loans. A near-unanimous 95 percent of the banks surveyed tightened the cost of credit to large and mid-sized commercial borrowers. Remember too that this is a leading indicator, as credit availability and demand now will help determine business capital spending and hiring next year.

So look for more of the same. More poor data, more stimulative spending, more bank intervention and more interest rate cuts.

At some point, it is not inconceivable that the Obama administration, in cooperation with their new partners at the Federal Reserve, begin to look at less conventional, and riskier, measures.

“Policymakers must also be contemplating more unconventional policy measures, such as outright monetisation,” Robert Lind, an economist at Royal Bank of Scotland, wrote to clients. “But I suspect they will only use these measures as a last resort, given the potentially negative implications for inflation and the dollar.”

If printing money rather than borrowing it becomes part of the debate, it will be very interesting to see how the United States’ international creditors react.

I’d bet it won’t be well.

— At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can reach him at —


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The US and UK economies are off balance – there has been too much use of highly geared and hidden debt to fund unsustainable spending at all levels of society leading to a massive misallocation of resources.

The great debt unwind needs to happen – but governments have deeper pockets than individuals and companies so can shoulder more debt for longer. However Government spending is frequently inefficient and arbitrary, making so called Keynesian policies dangerously slow and ineffective as well as potentially inflationary (so damaging to currencies and the cost of long term borrowing).

Governments therefore need to cut back hard on all non-essential spending (to avoid crowding out private investment and exacerbating the problem of resource misallocation) – aiming to bring spending below 30% of GDP. They should then increase short term borrowing to provide massive tax cuts to the 80% of the population with the lowest earnings and to the 80% of companies with the lowest turnover (who are most vulnerable to short term liquidity problems).

All borrowing is a tax on future earnings – but by cutting spending and handing money back to the people now, governments can help ensure that earnings continue to grow (although at a slower rate as people repair their own balance sheets).

True many people and companies will use spare cash to save or pay of debt in the first instance – but that is an essential first step to recovery. Making the tax cuts deep enough to make work more rewarding (and company investment more profitable) is the quickest route to stimulating new growth in the economy that meets the needs of individuals (the market is still the best allocator of resources).

At the same time essential government spending, wherever possible, should be directed through the beneficiary (so school vouchers and training vouchers for all).

This way to recovery may be harder and possibly longer than simply inflating away the debt – but the results will be all the more enduring for rewarding savers and the pain of learning to live within our means.

Posted by Huw Sayer | Report as abusive

Money is based on nothing. That is the problem. Furthermore, anyone who puts their retirement in the stock market deserves what they get. People need to learn a trade and get paid for what they do. Until the bankers and their greedy politician friends are prosecuted for what they have done, this problem will never be fixed. Obama should address the criminal aspects of the credit crisis and begin promoting individual lifestyles that arent based on credit. What happened to saving money then spending? It’s all just one big Enron!

Posted by ckh1213 | Report as abusive

The disclamer at the end of the article is a bit ironic. It says, “At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.”

Actually that disregards the central investment of everyone in the U.S. and most of the world for that matter. The U.S.dollar. We all have a direct investment in that security/asset class. After the government runs out of peas for their economic-rescue pea-shooter, the only thing left will be to monetize the debt created by the rescue. Of course the beauty of that is only the cogniscenti will actually realize the huge tax being levied without the consent of the taxed population.

That’s when we get really impoverished. That’s when the U.S. dollar becomes a third-rate currency. That’s when governments world-wide stop supporting the U.S. by staying away from Treasury auctions. Who cares if the U.S. Treasury debt is backed by the full faith and means of the U.S. government if it is a degenerating asset?

I believe James Saft is dancing around the obvious conclusion of his well-stated appraisal. We are off the cliff. The brain simply has not yet responded to the signals of gravity and acceleration. If you want a parachute, it will probably not be made of U.S. dollars.

Posted by Jonathan Cole | Report as abusive

We all should live within our means. However, wage earners are faced with layoffs while commissioned workers are simply starved out as the current contraction has caused these workers earnings to drop 50% or more. It hardly seems plausible that any one can sustain a mortgage under such conditions. Currently as many 10 million families Could be facing foreclosure. As the economy worsens the number of those at risk will only worsen. Where will all of these people live when they loose their homes. Should the federal government do as Alan Greenspan suggested and borrow or print money and absorb loses that mortgage holders incur? Is the alternative to have federal run banks to simply rent or assign places for the homeless families to live? Either is surely better than to have millions homeless and the inevitable consequences of such a disaster.

The free market is good at finding profitable enterprise’ and developing them to their full potential. It has not been able to direct resources to developing sustainable energy and food production allowing to move away from fossil fuels. The current collapse in crude and commodities makes alternatives more expensive and no ability to generate profits.

Some profitable endeavors are not good. Some good endeavors are not profitable. Thomas Paine stated that the choicest of gifts the the Creator bestowed apon us was Reason. Le us use it. We must loose our religion of economic and political thinking. Open minded deliberation will lead to pragmatic action. As citizens the responsibility is ours to clear our minds and inform our selves. Then we must all make our voices heard by our elected representatives. Trusting our leaders to address these problems on their own has failed. I trust the judgment of an informed citizenry far better.

Posted by Anubis | Report as abusive

this experiment with paper currency not backed with commodity and created out of thin air is now collapsing like a Ponzi scheme

the only regulation we need is: sound money backed by commodity and 100% reserve requirement for banks

money should be created through savigs, not via new debt

Posted by Mark | Report as abusive

It was all well and good for many years for these institutions to earn more and more money through these means. Only now it has failed are people looking at regulation. A bit late, perhaps?

Posted by Vardis | Report as abusive

Mr. Saft, what you’ve just said is one of the most insanely idiotic things I have ever heard. At no point in your rambling, incoherent response were you even close to anything that could be considered a rational thought. Everyone in this room is now dumber for having listened to it. I award you no points, and may God have mercy on your soul….

Posted by khonea | Report as abusive